Beyond the Finish Line: Why M&A Success depends on Post-Deal Due Diligence (with one example): Part 1

In the world of mergers and acquisitions (M&A), the focus is often placed heavily on pre-deal due diligence, examining financial health, legal compliance, and strategic fit to ensure the deal is sound before it closes. However, what is frequently overlooked is the importance of post-deal due diligence. In the rush to execute and integrate, many companies fail to give this phase the attention it deserves, and it can become a value-killer mistake. By splitting the due diligence process into two phases pre-deal and post-deal organizations can better manage risks while maximizing long-term value. Neglecting the post-deal phase can lead to unanticipated challenges that jeopardize the success of the entire transaction.

But how we can logically separate and frame the scope of the phases? How is a typical risk that may go unnoticed through the Pre-Deal Due Diligence? Let us see shortly together.

Pre-Deal Due Diligence (Traditional Phase) This phase focuses on assessing the most critical risks that could influence whether the deal should move forward. The goal is to uncover any major red flags or deal-breakers before closing the transaction.

Key areas covered:

• Financial health: Deep dive into financial statements, liabilities, and profitability.
• Legal and regulatory compliance: Checking for legal risks, pending litigation, or regulatory concerns.
• Key operational factors: Ensuring there are no major infrastructure issues that would derail integration.
• High-level cultural assessment: Surface-level look at leadership alignment, but typically not very deep.
• Strategic fit: Ensuring the deal aligns with long-term business goals.

Advantages: Pre-deal due diligence prevents companies from walking into obvious problems or overpaying, and it ensures the deal's financial viability.

Post-Deal Due Diligence (Extended Phase) This phase typically runs after the acquisition and dives deeper into more complex or softer issues that may not be fully assessable pre-deal but are crucial to long-term success. Post-deal due diligence should be an essential step of an integration plan aimed at delivering the value of the M&A deal.

Key areas can include but are not limited to:

• Detailed operational integration: Examining the IT systems, supply chains, and operational structures that need to be integrated.
• Cultural integration: Evaluating employee morale, cultural gaps, and ensuring the leadership team is engaged.
• Human capital: Assessing talent retention strategies and ensuring key personnel are motivated and engaged.
• Customer and market reactions: Monitoring customer feedback and potential market disruptions caused by the merger.

A complete post-deal due diligence provides the buyer the necessary visibility to address issues that are not critical to the deal itself but are crucial for long-term value creation. It also allows the acquiring company to assess the realities of integration and put in place a realistic plan, considering the actual roadblocks.

Why This Approach Works:

1. Time Efficiency: Some issues (like cultural fit or deep operational reviews) are better observed in real-world settings post-close, rather than overburdening the pre-deal process.
2. Risk Mitigation: Pre-deal diligence can focus on stopping catastrophic risks, while post-deal diligence can fine-tune and ensure value realization.
3. Integration Planning: By breaking down the process, post-deal due diligence becomes part of a structured integration strategy, allowing for adjustments and refinements based on real-time data post-transaction.

A typical example of pre-deal “unspotted risks” that must be caught during post-deal due diligence are inflated sales bookings. This risk often arises from how revenues are reported and recognized and may be deliberately or unintentionally misrepresented.

Here’s why inflated sales bookings can slip through pre-deal due diligence:

1. Revenue Recognition Complexity: Aggressive revenue recognition practices, such as booking sales that have not yet been realized or future sales expected but not yet confirmed, can inflate the company’s financial performance on paper.
2. Short-Term Boosting to Attract Buyers: Some companies might push sales teams to book as many deals as possible before the sale, inflating current period numbers but weakening future periods.
3. Quality of Earnings Review Limitations: While a quality of earnings (QoE) report is typical pre-deal, it may miss nuances, such as whether revenue is sustainable or of high quality.
4. Hidden Discounts or Extended Payment Terms: Sales may be booked with hidden discounts or extended payment terms, creating the impression of higher revenue, while cash flow remains weak.
5. Lack of Access to Internal Data: Pre-deal due diligence often relies on limited data provided by the seller. Buyers are typically not granted full access to the target company’s CRM systems, which contain critical information about customer relationships and sales pipelines. Even when access is provided, the quality of data within these systems may not reflect reality, with incomplete or outdated information creating a misleading view of performance and sustainability. This limited or flawed data can make it difficult to evaluate the true health and future prospects of the company’s revenue streams.

Conclusion: M&A success is not guaranteed by the deal itself but by the careful planning and execution that follows. While pre-deal due diligence prevents immediate issues, post-deal due diligence only can set the foundation to ensure long-term value creation. Unfortunately, many companies underestimate this phase, rushing into integration without fully understanding the deeper risks that could derail the deal. Taking the time to thoroughly assess the operational, cultural, and strategic challenges post-deal will not only reduce risk but also maximize the benefits of the acquisition, providing a clearer path to achieving the desired outcomes.

In the next days we will see more examples of other unspotted issues that typically a pre-deal due diligence is not able to capture.